A taxpayer successfully challenged an Ohio statute that imposed income tax on capital gain that the out-of-state investor realized when he sold his majority ownership interest in a pass-through entity. While this case does not focus on valuation specifically, it does raise a novel tax issue regarding a pass-through company.

The taxpayer owned a majority interest in a limited liability company that had plants in Texas and California and did some business in Ohio. It was organized as a pass-through entity for tax purposes. The taxpayer did not reside in Ohio. He was on the company’s board of managers but apparently did not actively manage the company.

After he sold his ownership stake in the company, Ohio claimed, under a statutory provision aimed at pass-through entities, he owed the state taxes related to capital gain from the sale.

The case ended up in front of the Ohio Supreme Court. The high court found Ohio had the authority to tax the taxpayer’s distributive share of the company’s income based on the company’s business activity in the state. However, without a showing that the owner’s activity was “unitary with” that of the business, the state lacked taxing jurisdiction over the nonresident’s income related to the sale of intangible property, i.e., the ownership interest in the business. The court ordered a refund for the taxpayer.

Mary Jo Dolson (Skoda Minotti), who has been monitoring the case, notes the case raises a key question: Would the outcome have been different if the owner had been involved in the day-to-day management of the company? Dolson adds that the state decided not to appeal the decision with the United States Supreme Court and that practitioners are awaiting guidance from the state on how it plans to handle refund claims.

The case is Corrigan v. Testa, 2016 Ohio LEXIS 1163 (May 4, 2016). A case digest and the court’s opinion are available in September at BVLaw.